US Dollar Monthly Exchange Rates Forecast - January 2025

Amid uncertainty surrounding the incoming Trump administration’s policies, interest rate differentials continue to favor long USD positions. The Federal Reserve, which shifted its focus from labor market concerns in September to prioritizing price stability by December, is expected to resume easing after Q1 due to a slowing labor market and downward revisions in nonfarm payroll estimates. Inflation pressures are also expected to ease, with CPI and core inflation showing significant declines in their rolling three-month annualized rates since early 2024. While some see a more hawkish Fed voting configuration, it is unlikely to significantly alter policy direction. The anticipated renewal of the 2017 Tax Cuts and Jobs Act by 2025 may be offset by spending cuts and tariff hikes, which, like those in Trump’s first term, are not expected to be strongly inflationary. However, rising Treasury yields, record-high CMBS rates, and increased credit card defaults signal growing vulnerabilities in the financial sector.

In 2024, the Bank of Canada aggressively cut its overnight rate by 175 basis points, including two half-point reductions in the final quarter, as inflation fell and economic momentum weakened. This pushed Canada’s discount to U.S. two-year yields to 130 basis points, the widest since 1997, and led to an 8% depreciation of the Canadian dollar against the U.S. dollar. The easing cycle is not over, with an additional 70 basis points of cuts anticipated in 2025. Politically, Canada faced turmoil as Finance Minister Freeland resigned—the fifth minister to step down. A no-confidence vote in early 2025 is likely to trigger a February election and a potential Conservative win under Poilievre, who may pursue a different approach toward the U.S. administration. Meanwhile, Canada’s critical minerals sector could offer leverage in the face of China's export restrictions, even as the U.S. dollar continues to strengthen.

The macroeconomic divergence between the U.S. and the eurozone remains pronounced as 2024 ends. While the U.S. two-year premium over Germany has narrowed slightly from 240 basis points in November to 216 basis points, it still exceeds all of 2023. The swaps market anticipates over 100 basis points of ECB rate cuts in 2025, compared to under 45 basis points from the Federal Reserve. Eurozone growth remains weak but could improve barring any major shocks. Politically, instability persists. France struggles to find a parliamentary majority for essential budget cuts, with President Macron's leadership in question. Germany faces a February election after a vote of no confidence, likely to result in a CDU-led government. Meanwhile, Ukraine's refusal to renew a key gas transit agreement with Russia has pushed natural gas prices to new highs, exacerbating Europe’s energy challenges. The eurozone's trade surplus with the U.S. could strain relations with the new administration, as threatened U.S. tariffs loom. While ECB President Lagarde urges restraint, weak European political leadership may feel pressured to retaliate, even as defense spending commitments rise, further complicating the economic and geopolitical landscape.

In 2024, all G10 currencies weakened against the dollar, but sterling posted the smallest decline, losing nearly 1.7% overall despite a sharp 6.4% drop in Q4. The $1.2000 level may soon be tested. Among G10 central banks that eased monetary policy, the Bank of England cut rates the least, delivering two quarter-point reductions starting in August. The swaps market anticipates 60 basis points of cuts in 2025, which seems modest given weak growth, a softening labor market, and an expected sharp drop in CPI early in the year. The UK economy unexpectedly stagnated in Q3, with similar performance expected for Q4, even as the Bank of England's 4.75% policy rate remains the highest in the G10. Politically, Labour's return to power in July after 14 years of Tory rule has been marred by scandals, infighting, and backlash over a controversial budget that included £40 billion in tax hikes. Prime Minister Starmer’s approval ratings have plummeted, while Nigel Farage’s Reform Party has surged in popularity, drawing support from across the political spectrum, including Conservatives, Liberal Democrats, and Greens.

The dollar rose 11.5% against the yen in 2024, marking a fourth consecutive annual gain and a cumulative 52% appreciation since the streak began. While Japan runs an overall trade deficit, its surplus with the U.S. could create friction with the new administration. The Bank of Japan continued its policy normalization, raising rates twice in 2024 to 0.25%, with markets expecting another 50 basis points of hikes in 2025, though expectations for a January increase have softened. December's CPI rise, driven by the expiration of energy subsidies, is unlikely to spur further action as the subsidies will return in Q1 2025. Japan's economy is stabilizing at a modest 0.2%-0.3% quarterly growth rate, while the yen's exchange rate remains more sensitive to U.S. Treasury yields and dollar strength (DXY) than to risk proxies like equities. Intervention threats from Japanese officials in December highlighted the yen's vulnerability, with such actions proving most effective when aligned with peaks in U.S. Treasury yields.

The specter of tariffs under Trump 2.0 has dampened sentiment, especially in China, where onshore equity markets fell over 5%, and USD/CNY breached the psychological 7.30 level after prolonged defense by authorities. Chinese 10-year bond yields dropped to 1.60% amid rising risk aversion and signals from the PBOC about potential rate cuts following mixed manufacturing PMI data. The spillover from USD/CNH surpassing 7.35 adds to the tension, as US-China relations face likely escalation in the coming months. While a prelude to de-escalation cannot be ruled out, skepticism remains over the possibility of a grand deal or a Mar-a-Lago accord.

USD/INR is projected to rise steadily toward 86.00 by Q4 2025, with the rupee expected to outperform other Asian currencies in the first half of the year, even amidst swift tariff increases. This outlook reflects a less favorable domestic growth environment in India, which could weigh on portfolio inflows. GDP growth projections for FY2024/25 and FY2025/26 have been revised downward to 6.1% and 6.3%, respectively, signaling a sharper slowdown than previously anticipated and highlighting economic challenges ahead.

Despite the RBA's relatively hawkish policy stance, the Australian dollar has struggled to gain significant ground. The AUD/USD pair remains heavily influenced by the strength of the USD, while market skepticism over the RBA’s “hawkish hold” persists amid slowing overall growth. The uneven performance of China’s economy and the lack of a clear trend in iron ore prices have contributed to the range-bound behavior of the Australian dollar. Although recent stimulus measures in China provide some support, their modest fiscal focus suggests only a limited impact on growth, further constraining upward momentum for the Aussie dollar.

The New Zealand dollar faces an uncertain outlook against the U.S. dollar due to a domestic recession and recent interest rate cuts by the Reserve Bank of New Zealand. Projections range from gradual strengthening to fluctuations near current levels, shaped by global economic trends, monetary policy, and market volatility.

In the short term, the inauguration of President Donald Trump carries significant implications for Mexico. While the threat of tariffs looms, it is widely expected that tariffs will not be imposed on USMCA partners, with negotiations likely to focus on shared issues such as immigration and drug trafficking. However, the potential impact of a 10% tariff could result in a GDP loss of 0.70% for Mexico, which would likely drive a sharp increase in the USD/MXN exchange rate, potentially reaching 22.00.